Six new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on August 20, 2020.
Recap from July’s Picks
On a price return basis, our Safest Dividend Yields Model Portfolio (+3.0%) underperformed the S&P 500 (+3.6%) by 0.6% from July 22, 2020 through August 18, 2020. On a total return basis, the Model Portfolio (+3.4%) underperformed the S&P 500 (+3.6%) by 0.2% over the same time. The best performing large cap stock was up 23%, and the best performing small cap stock was up 39%. Overall, eight out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from July 22, 2020 through August 18, 2020.
Only our research utilizes the superior data and earnings adjustments featured by the HBS & MIT Sloan paper,"Core Earnings: New Data and Evidence.” This Model Portfolio leverages our Robo-Analyst technology, which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.
This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because we know they have the cash to support the dividend. We think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.
Featured Stock for August: Bank of Hawaii Corp (BOH: $56/share)
Bank of Hawaii Corp (BOH) is the featured stock in August’s Safest Dividend Yields Model Portfolio.
Bank of Hawaii has grown revenue by 5% compounded annually and net operating profit after-tax (NOPAT) by 7% compounded annually over the past five years. Longer term, Bank of Hawaii has grown NOPAT by 3% compounded annually over the past decade. The firm’s NOPAT margin increased from 27% in 2014 to 32% TTM, while its invested capital turns improved from 0.42 to 0.46 over the same time. Rising margins and invested capital turns drive Bank of Hawaii’s return on invested capital (ROIC) from 11% in 2014 to 15% TTM.
Figure 1: Bank of Hawaii’s Revenue & NOPAT Since 2014
Sources: New Constructs, LLC and company filings
Cash Flow Supports Dividend Payments
Bank of Hawaii has paid a dividend in each of the past five years. The firm increased its dividend payments from $1.80/share in 2015 to $2.59/share in 2019, or 10% compounded annually. The current quarterly dividend, when annualized provides a 4.8% dividend yield.
Bank of Hawaii’s dividend payment is supported by the firm’s strong free cash flow (FCF). Bank of Hawaii generated $705 million (32% of current market cap) in FCF while paying $451 billion in dividends from 2015 to 2019, per Figure 2. Over the TTM, Bank of Hawaii has generated $172 million in FCF and paid out $107 million in dividends.
Figure 2: Bank of Hawaii’s FCF vs. Dividends Since 2015
Sources: New Constructs, LLC and company filings
Companies with strong FCF provide higher quality dividend yields because we know the firm has the cash to support its dividend. On the other hand, dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.
BOH Is Undervalued
At its current price of $56/share, BOH has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects Bank of Hawaii’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that Bank of Hawaii has grown NOPAT by 3% compounded annually over the past two decades.
Even if Bank of Hawaii’s NOPAT margin falls to 27% (10-year average vs. 32% TTM) and the firm grows revenue by <1% compounded annually, which results in NOPAT falling by 1% compounded annually over the next decade, the stock is worth $87/share today – a 55% upside. See the math behind this reverse DCF scenario.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings as shown in the Harvard Business School and MIT Sloan paper,"Core Earnings: New Data and Evidence”.
Below are specifics on the adjustments we make based on Robo-Analyst findings in Bank of Hawaii’s 2019 10-K:
Income Statement: we made $19 million of adjustments with a net effect of removing $3 million in non-operating income (<1% of revenue). See all adjustments made to Bank of Hawaii’s income statement here.
Balance Sheet: we made $233 million of adjustments to calculate invested capital with a net increase of $119 million. The most notable adjustment was $110 million (7% of reported net assets) in total reserves. See all adjustments to Bank of Hawaii’s balance sheet here.
Valuation: we made $292 million of adjustments with a net effect of decreasing shareholder value by $44 million. Apart from total debt, one of the most notable adjustments to shareholder value was $45 million in underfunded pensions. This adjustment represents 2% of Bank of Hawaii’s market value. See all adjustments to Bank of Hawaii’s valuation here.
This article originally published on August 28, 2020.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
 Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.